In Eco-political analysis, Energy

Prior to the pandemic, Brazilian President Jair Bolsonaro, a far-right former military captain, was facing dwindling support. He was sworn into office on January 2019, soon after the monumental Car Wash corruption scandal and the deepest recession in the country’s history. Campaigning with promises of eliminating the traditional horse-trading politics and rooting out corruption, the expectations were high for Bolsonaro and his esteemed market-friendly Economic Minister, Paulo Guedes. Investors at home and abroad thought they would quickly reignite the economy and usher through structural reforms. But in the administration’s first year in office, the economy grew a mere 1.1%, far below the 2.6% expected by economists. [1, 2]. A close aide to Bolsonaro’s son, Flavio, was also charged for the embezzlement of funds.

Many upper-middle class people, especially in the South, became tired of Bolsonaro’s constant bickering with Congress and his inability to work collaboratively with the legislature. His failure to adhere to red flashing signs coming from the pandemic in Europe culminated when he attempted to prevent states from locking down. In mid-May, his approval rating fell to its lowest level since he took office. [3]

The resignation of former Justice Minister Sergio Moro, the people’s messiah in the fight against corruption, was the cherry on top for Bolsonaro’s opponents. To avoid impeachment, Bolsonaro formed a coalition with the infamous Centrão, a centrist group of old-school politicians at the forefront of many corruption scandals. These politicians exchange votes for important positions in the ruling administration, controlling large budgets and federal payrolls for their party members in their home states. Kevin Ivers, Vice President at public affairs firm DCI Group, bluntly stated that, “Bolsonaro would likely have been impeached this year, if it were not for his deal with the Centrão at that moment. It allowed his critics to say he’d put up a “for sale” sign.” Bolsonaro specifically campaigned against this old-school system of politics, making this symbolic “for sale” sign even more frightening for Brazilian observers.

This change of heart will have wide-ranging implications for the Bolsonaro administration. With the support of the Centrão coalition, Bolsonaro’s impeachment chances are now essentially null. He has enough support in Congress to block any initiative to remove him from office. Secondly, corrupt politicians with shady track records will now take over top-level positions, where they will control billions in government funds and lead important ministries. Lastly, the prospects of structural reforms have slightly improved — but not by much.

Can Reforms Still Happen?

The probability and speed of reforms still hinges largely on Rodrigo Maia, the Speaker of the House of Representatives. On the eve of Paulo Guedes’s symbolic delivery of the tax reform proposal to the legislature, Maia decided to hold a vote on Fundeb, a fund allocated for primary education. Maia essentially disregarded the fanfare surrounding Guedes’ tax reform and reemphasized his control over the country’s legislative agenda. Unless the Bolsonaro administration is able to improve relations with the Speaker, future reforms will progress at Maia’s own pace.

However, the need for structural reform and a clear strategy to reign in future spending is dire. Although the pension reform in 2019 was fundamental, it consumed a lot of Bolsonaro’s political capital and was diluted by the time it reached the President’s desk. Vitor Vidal, economist of Brazil’s biggest equity-broker firm XP Investimentos, said that that pension reform simply postponed the fiscal problem for 10-15 years. Tax reform will be just as difficult. None of the experts we spoke to expect the bill to be passed this year. Administrative reform, facing less political goodwill and stronger lobbying, will be even harder to push through. Experts emphasize that reform negotiations must reach an advanced stage by the end of this year; the introduction of the first phase of the tax reform bill on July 21, was a good sign.

Deforestation Debacle

On the international front, Bolsonaro’s main headache is the Amazon. The severe illegal deforestation that is plaguing the biome should not be taken lightly. In 2019, at the hands of criminals,1,900 soccer field-sized sections of natural forest were destroyed per day, the largest amount since 2008. The Amazon destruction data for 2020 is looking even worse. [4] After pressure from trade partners and international investors holding nearly $4 trillion in assets, Bolsonaro urged the military to pay full attention to investors’ requests for change. Bolsonaro’s views on the Amazon as a source of economic gains have not changed, but the circumstances are no longer the same. The importance of foreign money to revamp the economy and stabilize the currency is essential. As he did in 2019, Bolsonaro temporarily appeased tensions by issuing a decree prohibiting forest fires for 120 days.

Strengthening Ibama, the Environmental Protection Agency, will help expand enforcement and prevent uncontrolled damages. Delivering tangible results, by establishing clearer land demarcations and reforesting at an acceptable rate, will help assuage some investor concerns. Developing the sustainable finance market in Brazil, which accounts for less than one percent of the world’s $240 billion green bond market, will also help fund environmentally friendly projects. [5] Without immediate changes, the Amazon will reach a tipping point—not only causing permanent damage to the environment, but directly affecting farmers’ ability to harvest crops in the surrounding regions.

Brazil’s far left and foreign interests are also taking advantage of the complexities of the deforestation issue for their agendas and personal gains. Kevin Ivers, from DCI Group, says Brazilian agricultural industry leaders feel Bolsonaro has completely lost control of the narrative and played right into President Emmanuel Macron’s hands. Macron smartly used the outrage over the Amazon fires to reject the Mercosur trade deal, all while gaining favor with French farmers. With a better communications strategy and mastery of the facts, Bolsonaro could have avoided this unforgiving migraine.

A Battered Economy

On the economic front, a natural inclination is to look at the Brazilian currency, the Real, which has depreciated more than any other currency in the world. After speaking to many leading economists, the inclination for the mid-term is that the currency is likely to stay within the range of R$4.80 to 5.30 for every USD 1. Certain factors, such as the quick approval of a comprehensive tax reform in the Brazilian congress and the victory of Joe Biden in the U.S. presidential elections, could push the currency to the lower echelon of 4.50. But as the economists at Hedge Fund Ace Capital put it, “It is very, very unlikely that the Real will go back to R$4.” Sergio Goldenstein, the former head of open market operations for the Central Bank, said that the proper equilibrium of the USD/BRL is R$5.00. It now stands at R$5.42.

In an effort to stimulate exports and domestic tourism, Economic Minister Paulo Guedes has said that he is comfortable with a slightly depreciated currency if it is accompanied by low interest rates. Such comments are worrisome for the Real. Even more concerning is if local and foreign investors continue to ship their money offshore. Discouraged by low interest rates, a slower-than-expected economic recovery and a volatile political environment, Brazilians increased their foreign holdings by 20% in the past 12 months. [6] When considering foreign investments in Sao Paulo’s stock exchange, a record U$70 billion flew out of the country in the first four months of 2020. [7] Goldenstein warned that the Real can “take off” if necessary fiscal policies are not implemented.

Retail sales, a strong indicator of the recovery of the economy, were up 8% for the month of June (compared to May) and 0.5% higher from a year earlier. Albeit this was the first year-on-year increase since February, economists warn that the numbers may be misleading; the upbeat figures are likely a byproduct of large stimulus handouts and pent-up demand. [8]

Brazil’s gross debt is also expected to see a 20% increase due to higher spending and lost revenues, reaching 96% of GDP by the end of 2020. The average indebtedness for emerging markets is expected to reach 63%, a much more sustainable level. [9] Through the approval of an emergency ‘war budget,’ Brazil’s federal spending ceiling for the year was eliminated. Moving forward, the government must be extremely careful not to meddle with this fiscal cap. Such an action could lead to a credit rating downgrade, severely hurting its ability to borrow and payback debt.

The informal economy, which makes up 41% of the workforce and 17% of GDP, is also being massively impacted by the lack of consumers on the street. [10] Informal workers are costly to hire and train, making a transition to the formal economy more difficult. In general terms, less than half of the total working age population is employed, 24% of which have been looking for a job for at least two years. [11] Pedro Silveira, economist at Nova Futuro Investimentos, only expects the economy to recover to its pre-pandemic levels between the end of Q1 and the beginning of Q3 2022. The recovery of the economy to its pre-recessionary 2014 levels will take many more years after that.

Stopgap Solutions: Privatization and Mining

The situation among states is even worse. Vitor Vidal, from XP, said that Rio de Janeiro, Minas Gerais and Rio Grande do Sul, traditional states that have older populations and overinflated expenditures, have grown their public employee payroll to a point of no return. Lack of tax revenues coming in, a major source of income, has worsened the situation. Many states are unable to pay their dues; they also struggle to raise capital because they are prohibited from issuing debt. While individual pension and administrative reforms are needed to cut down costs, the near-term solution is to privatize state entities and make a quick buck. Rio de Janeiro is desperately trying to privatize CEDAE, its sanitation company, while Rio Grande do Sul is looking to offload its energy assets. Investors looking to snap up cheap assets, albeit with complicated histories, could be in luck.

Opportunities also exist at the national level with the planned privatization of Electrobras and the de-monopolization of the gas market. But as any important law in Brazil, the bill privatizing Electrobras will be a complicated task. The privatization’s first failed attempt was under President Temer in 2018, and experts warn that the current bill does not have enough support in congress to be approved in its current state. In mining, the Ministry of Mining and Energy is speeding up concession processes to allow for more mining activity in additional areas. As Brazil struggles with the outflow of foreign capital, expect more mining projects to go online as the government desperately seeks to gain access to the world’s dominant currency. Mining exports is one of the ways to do it.

Contact us if you’re interested in market intelligence that goes deeper in weighing these challenges in Latin America, particularly in the areas of political risk, economic risk, reputational risk, investment research and more.


[1] O Globo

[2] BBC

[3] XP/Ipespe Poll

[4] O Globo

[5] Bloomberg

[6] Folha de S. Paulo

[7] Correio Brazileirense

[8] Reuters

[9] Valor

[10] O Globo

[11] O Globo



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